With the worsening humanitarian crisis in Ukraine, international sanctions against Russia, ongoing conflict in the Middle East, and long Covid in China, market performance is more unpredictable than ever before. Thus, it is vital that investors understand the magnitude of the risks they are taking and become familiar with ways to potentially mitigate losses.
One of the biggest issues we are facing today is hyper-inflation. Around the world, we have seen price surges due to supply chain bottlenecks from Covid lockdowns and international sanctions from war. These price surges include that of crude oil, with Brent soaring to its highest level in seven years. The consumer price index in the US increased by 7.9% over the past 12 months, and the European Union reported an annual inflation of up to 7.5%. Both advanced and emerging economies in Asia experienced higher energy and food prices due to pandemic disruptions.
Historically, rapid inflation is bad for investments in stocks and bonds because it erodes the purchasing power of the investor and diminishes the value of his holdings. It is also bad for savings, because money held in savings accounts do not grow much. With inflation running high, savings will be at risk of losing value as the same amount of money will allow you to buy less.
Rising inflation raises the prospect of a period of economic stagnation to follow, or worse, a recession. To protect against volatile times ahead, investors can shield their investments with some of these more advanced tactics.
Portfolio diversification is a well-known tactic for investors looking to navigate market turmoil without suffering great losses. In times of instability, different types of assets – most notably precious metals such as gold and silver – are used as hedges, and many investors take short positions in bearish markets, hoping to cushion their losses. While these may be the most popular ways of minimising damage done by volatile markets, they are not the only ones.
In a talk at the Singapore Trading Festival which took place over the first weekend of April 2022, Saxo Markets Singapore’s Chun Fei Lin shared some advice on navigating unstable markets. While she advises investors ‘rebalance their portfolio’ by investing in gold and other commodities, she makes a point to direct their attention to ‘Real Estate Investment Trusts (REITs)’ and ‘Treasury Inflation Protected Securities (TIPS)’.
Gold is widely regarded as a haven in times of market volatility as it is largely unaffected by the performance of other assets. Commodities (outside of metals) encompass a diverse range of products, some of which are negatively correlated with stocks and bonds. These include corn and livestock, which can serve as havens against the threat of inflation as well.
However, it can serve investors well to look beyond these two common hedges.
A Real Estate Investment Trust (REIT) is a collective investment scheme that is often described as being ‘recession-proof’. It aims to deliver a source of recurrent income to investors through focused investment in income-generating properties. Directly investing in high-quality real estate can be difficult as it requires large amounts of time, capital, and industry knowledge. REITs offer investors the option of having a diverse portfolio of shopping malls, offices, hotels, both locally and globally, without those challenges.
During inflationary periods, REITs can benefit from rising real estate prices and provide a stable dividend for investors.
Treasury Inflation Protected Securities (TIPS) are a type of Treasury security issued by the US government, which can be purchased by anyone through a bank or a broker. TIPS are indexed to inflation in order to protect investors from declines in the purchasing power of their money. In other words, when inflation rises, TIPS adjust in price (principal amount) and maintain their real value.
Therefore, the principal amount investors put in will always be protected, and investors will never receive less than their original investment. Additionally, TIPS are also a popular asset in inflationary periods because they pay interest biannually based on a rate determined by the value of the bond. This means that investors even receive higher interest or coupon payments as inflation rises.
While portfolio diversification can be a great way to protect against inflationary periods, investors are faced with a different challenge in volatile markets where great spikes can take place quickly and without warning. During these unstable times, investors can look to buy put options, which is a huge draw as a hedging strategy in volatile markets.
Buying a put option gives the buyer the right to sell an underlying asset at the price stated in the option within a predetermined timeframe. By purchasing a put option, the investor is essentially buying time and transferring the downside risk to the seller while they observe market conditions. If the transaction does not work out, the buyer loses the premium paid for the option but nothing more than that.
Faced with volatile markets, investors can also pull back to safe zone by moving to cash or cash equivalents partially or completely. Though this is not advisable in times of rapid inflation, it is a wise decision when markets are simply too unpredictable for anyone to make calls.
In the world of investment, sometimes cutting your losses is the only option you may have. By getting out quickly, you may not end up making a huge profit from your investments, but you will not be suffering great losses either. When the market shows signs of stabilising, you can turn your cash back into equity holdings.